Q4: An investor has the choice of an AA-rated corporate bond with a yield of 6%
ID: 2784273 • Letter: Q
Question
Q4: An investor has the choice of an AA-rated corporate bond with a yield of 6% or an AA-rted muni yielding 490. Please complete the table and answer the questions below Yield Bond Rating Municipal Corporate Municipal Yield (%) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Corporate After-Tax Yleld (%) Munis' Tax Equivalent Yleld (%) Investors, Marginal Tax Bracket (%) 10% 15% 25% 28% 30% 30% 5% 40%, Corporate Yield (%) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% If the investor has a marginal tax rate of 30%, which bond should he/she select? If the investor has a marginal tax rate of 35%, which bond should he/she select?Explanation / Answer
Corporate Yield = 6%
Municipal Yield = 4%
Municipal Bonds are tax-free bonds, while interest on corporate bonds are taxable.
Hence, After-tax yield on corporate bond = Corporate Yield x (1 - tax rate)
Municipal Equivalent Yield = Muni. Yield / (1 - tax)
At 30%, select corporate bond as corporate after tax yield > municipal yield, or in other words, municipal equivalent yield < corporate yield
At 35%, select municipal bond as corporate after tax yield < municipal yield, or in other words, municipal equivalent yield > corporate yield
Tax Muni. Yield Corp. After tax Muni Equi. Corp. Yield 10% 4.00% 5.40% 4.44% 6.00% 15% 4.00% 5.10% 4.71% 6.00% 25% 4.00% 4.50% 5.33% 6.00% 28% 4.00% 4.32% 5.56% 6.00% 30% 4.00% 4.20% 5.71% 6.00% 33% 4.00% 4.02% 5.97% 6.00% 35% 4.00% 3.90% 6.15% 6.00% 40% 4.00% 3.60% 6.67% 6.00%Related Questions
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